Is AD Plastik d.d (ZGSE:ADPL) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies AD Plastik d.d. (ZGSE:ADPL) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for AD Plastik d.d

How Much Debt Does AD Plastik d.d Carry?

The image below, which you can click on for greater detail, shows that AD Plastik d.d had debt of Kn379.9m at the end of March 2021, a reduction from Kn471.5m over a year. On the flip side, it has Kn52.5m in cash leading to net debt of about Kn327.4m.

How Strong Is AD Plastik d.d's Balance Sheet?

The latest balance sheet data shows that AD Plastik d.d had liabilities of Kn433.7m due within a year, and liabilities of Kn200.7m falling due after that. Offsetting these obligations, it had cash of Kn52.5m as well as receivables valued at Kn291.9m due within 12 months. So it has liabilities totalling Kn290.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since AD Plastik d.d has a market capitalization of Kn794.4m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

AD Plastik d.d has net debt to EBITDA of 2.6 suggesting it uses a fair bit of leverage to boost returns. But the high interest coverage of 7.5 suggests it can easily service that debt. Shareholders should be aware that AD Plastik d.d's EBIT was down 28% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine AD Plastik d.d's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, AD Plastik d.d's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over AD Plastik d.d's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making AD Plastik d.d stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for AD Plastik d.d that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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